Banking

Banks buy time restructuring loans, for the moment

U.S. lenders have more than $40 billion of such loans deemed performing assets

By

AlistairBarr

SAN FRANCISCO (MarketWatch) -- More U.S. banks are restructuring troubled loans as commercial real-estate problems replace pressure from the residential housing bust.

Restructuring buys more time for borrowers to get back on track and may help banks avoid bigger loan losses. However, it may only buy banks time before problems re-emerge once again.

"Asset quality appears to have stabilized, but we just don't know the impact of all these restructured loans," said Paul Miller, a banking analyst at FBR Capital Markets. "This could mean problems persist for longer than investors expect."

The mortgage meltdown and ensuing financial crisis left U.S. banks with billions of dollars worth of bad loans. The government and regulators have been pushing banks to modify mortgages to limit foreclosures through efforts like the Home Affordable Modification Program, or HAMP.

The next worry is commercial real estate, or CRE, which has been hit hard by vacancies fueled by rising unemployment. Banks could lose $200 billion to $300 billion on CRE loans, according to a February report by the Congressional Oversight Panel -- a watchdog for the government's $700 billion Troubled Asset Relief Program. Read about COP's warning.

"Regulators are concerned about a looming wave of maturing commercial real-estate credit in 2010 and beyond," Todd Hagerman, a banking analyst at Collins Stewart, said in an interview. "To get ahead of that, they want banks to become more active on restructuring these loans now."

If banks successfully restructure a loan, the risk rating drops and they don't have to set aside as many reserves on such assets, he elaborated.

"Some investors cry foul, arguing this is another version of 'extend and pretend,'" Hagerman added. "But the economy is improving and this gives more time for borrowers to get back on their feet."

$41 billion

Publicly traded U.S. banks and thrifts had more than $41 billion of restructured loans that they deemed performing at the end of September, according to SNL Financial data analyzed by MarketWatch.

Citigroup Inc.
C, -1.64%
had almost $12.5 billion of performing restructured loans on Sept. 30, accounting for 1.91% of the giant bank's total loans and leases, SNL data show.

J.P. Morgan Chase & Co.
JPM, -1.56%
and Wells Fargo & Co.
WFC, -1.69%
had more than $5 billion of performing restructured loans at the end of September, making up less than 1% of their total loans and leases. Bank of America Corp.
BAC, -2.27%
had $3.9 billion of such assets, making up less than 0.5% of total loans and leases, according to SNL data.

For some smaller banks and thrifts, performing restructured loans make up a much larger proportion of their total loans and leases.

Redefaults

These loans often aren't included in nonperforming assets, a closely watched measure of credit problems. That may give a rosier view of credit quality in the industry.

But this may not last because restructured loans can redefault later, falling back into nonperforming status.

"The redefault rate is very high so we're pretty cautious about the future performance of restructured loans," Fred Cannon, a banking analyst at Keefe, Bruyette & Woods, told MarketWatch. "Bankers try and it's worth making the effort, but it doesn't always work out."

Last year, the Federal Reserve Bank of New York studied subprime-mortgage modifications in which monthly payments were "meaningfully reduced." The study, published in December, found that roughly 57% of the loans redefaulted in the first year -- a rate it described as "distressingly high."

'A degree of hope'

Publicly available information about loan restructurings, or workouts, in the commercial real-estate market is "extremely limited," so it's tough to analyze whether such efforts are succeeding, the Congressional Oversight Panel said earlier this month.

Of almost $140 billion of troubled commercial-mortgage assets in the United States, $17.1 billion worth have been modified in some way, COP noted, citing data from research firm Real Capital Analytics.

"Lenders have an incentive to work with borrowers, where possible, to delay, minimize or avoid writing down the value of loans and assets," COP said. "The hope is that the economy will improve or that commercial real-estate loans will not be as problematic as expected."

However, if the commercial real estate market doesn't rebound as quickly as lenders expect when they restructure loans, re-default is likely, the watchdog added.

Construction-loan workouts often involved "a degree of hope" that the market will turn around pretty quickly, according to COP.

"Supervisors bear a critical responsibility to determine whether current regulatory policies that attempt to ease the way for workouts and lease modifications will hold the system in place until cash flows improve, or whether the supervisors must take more affirmative action quickly ... even if such action requires write-downs (with whatever consequences they bring for particular institutions)," it said.

"They must be especially firm with individual institutions that have large portfolios of loans for projects that should never have been underwritten," the watchdog stressed.

'For want of a nail'

One problem is that potential new commercial real estate tenants can't get small loans to build out space for start-up businesses, according to Mack Gibson, a lawyer who owns commercial retail centers in Texas.

Gibson said he's able to accept lower rents and still make payments on the commercial mortgages underlying his properties. There's also been a recent increase in inquiries from potential new tenants. But regulators won't let banks make loans to even creditworthy tenants for build-out costs.

Without such loans, which can be for as little as $15,000, some of Gibson's space remains empty.

"For the want of a nail, these buildings remain empty," he said in an interview. This could end up hurting banks in the long run because more of their commercial real estate loans may go bad because of lingering vacancies, Gibson added.

Umpqua

Umpqua, a Portland, Ore.-based community bank, had $182.2 million of impaired loans that it classified as performing restructured loans at the end of September. That was up from $23.5 million at the end of 2008.

Meanwhile, nonperforming assets were $156 million, or 1.7% of total assets, on Sept. 30, down from $161 million or 1.88% at the end of 2008.

In late January, when Umpqua reported fourth-quarter results, the company reclassified $48 million of performing restructured loans as nonperforming. That fueled a 43% jump in nonperforming assets during the quarter to $223.6 million.

"It was disappointing to see the credit-quality trends in the fourth quarter of 2009," Brett Rabatin, a bank analyst at Sterne Agee, wrote in a note after Umpqua's results came out.

Investors were probably disappointed by the level of net charge-offs and the $48 million shift from restructured loans to nonperforming assets in the quarter, he said.

Umpqua shares dropped 6.5% on Jan. 28 when the results were released.

In an interview about two weeks after the results, Rabatin pointed out that Umpqua shares may have fallen for other reasons.

On Feb. 4, Umpqua said it raised more than $250 million in capital selling new common stock at $11 a share. The offering diluted existing shareholders and pressured the stock further.

But the share sale also gave Umpqua more financial firepower to help the bank bid for failed rivals.

Indeed, less than a week before Umpqua reported disappointing fourth-quarter results, it won the bidding for failed Seattle-based lender Evergreen Bank. The Federal Deposit Insurance Corp. agreed to share losses on $380 million of Evergreen's assets -- a potential boon for Umpqua.

In February, Umpqua used $214 million from its share sale to repay government money it got from the Troubled Asset Relief Program. The bank said it may use the rest for more acquisitions of failed banks like Evergreen, if regulators approve.

Such approval may not come easily. Sterne Agee's Rabatin said that investors expected Umpqua to win the bidding for The Dalles, Oregon-based Columbia River Bank, another failed institution that was bigger than Evergreen with more than $1 billion in assets.

Columbia State Bank, based in Tacoma, Wash., ended up buying Columbia River when it failed in January.

M&I

Marshall & Ilsley Corp.
MI
had $935 million of performing restructured loans at the end of September, up from less than $90 million a year earlier, according to a regulatory filing by the bank.

The performing restructured loans made up almost 2% of Marshall & Ilsley's total loans and leases on Sept. 30.

The bank said it usually restructures loans by cutting interest rates and extending maturities, lowering monthly payments. That reduces the risk of losses, it added.

Marshall & Ilsley said that so far redefaults on restructured consumer-related loans have been relatively low, noting that roughly $53 million, or 5.7% of restructured loans, were 30 to 89 days late.

However, the bank also warned that its experience with restructured-loan performance is "relatively new and does not encompass an extended period of time."

About two-thirds of Marshall & Ilsley's restructured loans were consumer-related at the end of September.

However, the bank is also exposed to commercial real estate. At the end of 2009, it had $13.8 billion of CRE loans, making up more than 30% of total loans and leases.

Washington Federal, PacWest

Washington Federal had $117.2 million of performing restructured loans on Sept. 30. That jumped to $172.6 million by the end of 2009.

The thrift also reported about $30 million of restructured loans that have gone bad again. That was up from almost $20 million at the end of September, according to a recent regulatory filing.

Nonperforming assets and performing restructured loans made up 5.73% of total assets at the end of 2009, an increase from 5.36% three months earlier.

Washington Federal also said it had more than $300 million of loans that are less than 90 days late, but are considered "substandard" for other reasons. If these assets are deemed troubled too, then nonperforming assets and restructured loans jump to 8.35% of total assets, the thrift warned.

PacWest had $194.9 million of restructured loans at the end of September. More than $50 million, or 27%, or those loans were nonperforming, the lender noted in a regulatory filing.

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